This potential would permanently depress revenue and

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Unformatted text preview: UES FOR DISCUSSION ID13–1 a. The net income and comprehensive income for CVS are very similar due to the relatively low dollar amount of changes to equity that did not also affect profitability. Caterpillar, on the other hand, saw a significant drop ($3,788 million) from net income to comprehensive income due to losses from foreign exchange, pension obligations and securities holdings. b. Caterpillar operates globally, so it must deal with foreign currency exposure; as shown, if exchange rates move against the company, hits to equity occur. CVS is mainly focused on its domestic retail operations, so it does not have this same exposure. Caterpillar has negotiated labor contracts with its production employees that specify some defined benefit pension obligations for the company, which bring into effect market and interest rate risks that can create equity losses for the company. CVS employs a different type of workforce and does not offer its employees the same type of retirement benefits. c. An analyst would focus on the companies’ profit levels, but would also focus on what other factors could harm the company’s equity cushion. A certain level of expertise and understanding in foreign exchange markets and trends would be required for an analyst following Caterpillar; an analyst focused on CVS would not be as concerned with the FX markets. Similarly, an understanding of pension accounting and assumptions appears more important for an analyst following Caterpillar than it would for someone following CVS. ID13–2 a. Tightened credit markets will mean less volume in debt issuances. Since each issue is rated by an agency, the revenue of the ratings agencies will decline as the number of debt issuances declines. b. The income statement will be directly affected with a drop in revenue and a consequent drop in profits. Stockholders’ equity will be affected due to the reduced net income shown on the income statement. To balance the lowered equity, the ratings agencies will either reduce asset balances or increase liabilities. c. It is very possible that the companies will see less volume in the future, even if the credit markets return to their previous levels. It is possible that we will see a restructuring in the markets, with less emphasis placed on the ratings assigned by outside agencies. Given the fact that the agencies assigned inaccurate grades on the mortgage­backed securities, and the fact that these inflated grades caused investors to lose principal, it is very possible that investors will look to a different mechanism to help understand risk. This potential would permanently depress revenue and profit levels for the ratings agencies. ID13–3 a. For an event to be classified as extraordinary, the event must have been both unusual in nature and infrequent in occurrence. b. If the eruptions continue periodically, then such eruptions would probably not be viewed as being infrequent in occurrence. Thus, any losses resulting from future eruptio...
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